Is an 'Economic Separation Barrier' the Key to the Future of Israel-Palestine?

Like it or not, the Palestinian and Israeli economies are bound together with ties that no political arrangement could sever

Palestinian women walk past a stall displaying T-shirts in Jerusalem's Old City, November 9, 2016.
AMMAR AWAD/REUTERS

Around six weeks ago, Finance Minister Moshe Kahlon announced an ambitious program aimed at lowering the expenses of millions of Israelis, particularly lower- and middle-income families. Kahlon and his aides presumably did not consider the plan’s effect on several million people who are not Israeli. Reducing taxes and customs fees on clothes, shoes and mobile devices is also keenly relevant to the Palestinians living in the West Bank and the Gaza Strip. It is therefore not surprising to learn that when Kahlon met recently with Palestinian Authority officials, as part of their regular contacts, the program was discussed.

The Bank of Israel’s May 29 decision not to change the interest rate for June also affects the Palestinians, for whom the Israeli shekel is an important currency.

Like it or not, the Palestinian and Israeli economies are bound together with ties that no political arrangement could sever.

“One of the main characteristics of the Israeli public in its approach to the conflict with the Palestinians is the desire for it to simply go away: Israelis simply do not want to hear from the Palestinians,” says Yuval Benziman, who teaches conflict research at Herzliya’s Interdisciplinary Center. That, he feels, is one of the reasons for the contradictory attitudes regarding a solution to the conflict with the Palestinians that is reflected in polls of Israelis. But even if a peace agreement is reached, these intertwined economies cannot be separated.

And so, on the 50th anniversary of Israel’s occupation of the West Bank, the shekel exchange rate and the index of Israeli food prices are as relevant to Palestinians as they are to Israelis.

Yet the Bank of Israel does not factor the Palestinian economy into its considerations. The job descriptions of Israel’s finance minister and the governor of the Bank of Israel is to guarantee Israel’s economic growth and stability. The state of the Palestinian economy is of no concern to them.

True, the Palestinian Authority has its own governor, banking supervision department and finance minister. But due to the tremendous influence of economic and monetary decisions in Israel, there are aspects of the Palestinian economy that are simply not managed.

For instance, the customs union between Israel and the PA prevents the PA from taking independent steps to protect its industry from imports.

In another example, the fact that tens of thousands of Palestinians working in Israel pay income tax according to Israeli tax brackets constrains the PA’s ability to collect taxes according to its needs. What in Israel is considered the minimum wage, on which tax rates are negligible, is the average wage in the West Bank, so it is quite possible that the PA would raise income taxes on West Bank Palestinians working in Israel, if it could.

“The Palestinians aspire to complete economic independence. One way to achieve this is an attempt to demonstrate monetary capability that is being managed as an independent entity,” says Ido Zelkovitz of Mitvim, the Israeli Institute for Regional Foreign Policies. “The Palestinians tried to prove such capability from 1999 to 2001, while attempting to declare an independent state, and began preparing to issue a Palestinian pound,” he adds. “There is an unequivocal understanding among the PA leadership that without monetary independence, political independence will not be achieved.”

The embrace of the two economies starts from the foundation. The Palestinian Authority and the Gaza Strip have no currency of their own; they use the shekel, the Jordanian dinar, the dollar and the Egyptian pound. More than 40% of Palestinian bank accounts are in shekels, and about 20% of their deposits and loans are made in shekels.

Say it with shekels

By and large, the day-to-day transactions in the West Bank are carried out in shekels, while larger transactions, such as dowries and property purchases, are done in Jordanian dinars or dollars, if only because Israeli banks rarely extend credit to Palestinian businesses in the West Bank. The banks are deterred by the difficulty of enforcement and of recovering problem debt, as well as by strictures imposed by the United States as part of the efforts to halt funding to terror organizations.

Palestinians barely invest in Israel, because of the economic disparities as well as fear of stigma from their own communities. So credit in the PA is usually in dollars or dinars. One might think the interest rate on the shekel wouldn’t affect investments in the Palestinian Authority but it indirectly affects the entire Palestinian economy, due to Israel’s dominance in all aspects.

In 2014, 92,000 West Bank Palestinians — 12% of employed Palestinians in the West Bank — worked in Israel. Half of them worked in Israel’s construction industry, where they represented 15.3% of the workforce. Before the first intifada broke out, in 1987, around half of all employed Gazans and one-third of employed West Bank Palestinians worked in Israel.

Even today, the relatively high number of Palestinian construction workers in Israel means that relations with the PA affects productivity: A construction worker who wastes hours at checkpoints every day is necessarily less productive.

Dependent on Israel

Two-thirds of all goods imported into the PA come from Israel, and their value is equal to one-third of the PA gross domestic product. Sales to Israel account for 81% of the PA’s exports.

The PA is Israel’s second-biggest export market, after the United States, for services and commodities. Israel’s trade with the PA is not officially defined as exports or imports, since the Paris Protocol, the economic annex to the 1994 Oslo Accords, notes that they have a customs union.

Yet Israelis seem to dismiss the economic importance of the PA and the Gaza Strip, and their millions of residents. Economically, Israel is an elephant living next to a fly. The Palestinian GDP is 7.4% of Israel’s. Per-capital GDP is about $40,000 a year in Israel, and $4,000 in the PA.

The trade balance is understandably skewed in Israel’s favor. Israeli sales to the PA in 2012 amounted to 16.4 billion shekels ($4.6 billion, excluding goods the Palestinians buy from the settlements. PA sales to Israel amounted to 3 billion shekels. The PA also got 4.3 billion shekels for Palestinian labor in Israel but even after that, the imbalance is 9 billion shekels.

Exports to the territories amount to 5% of total Israeli exports, 8% excluding diamonds. That’s 1.7% of Israel’s GDP. Little of that is high-tech; most is low-tech industry and energy.

In addition to its military advantage, Israel’s economic advantage over the PA is one of the factors why there’s little pressure in Israel to reach a political solution. As the co-founder, managing director and treasurer of the Economic Cooperation Foundation, Boaz Karni, puts it: “Let’s assume that trade with the PA stops. The Israeli food industry might feel a pinch, but other industries would probably not take a hit. So [the Palestinians] would buy cement from the Jordanian monopoly instead of the Israeli monopoly. So Israel does not really care either what exactly the fate is of relations between the parties.”

Yet per-capita GDP of just $4,000 means a vast potential for growth, which would have a positive impact on the Israeli economy.

Meanwhile, the PA deficit before external funding in 2014 was close to 6 billion shekels. Net revenues were a mere 9.3 billion shekels. The PA’s debt to Palestinian banks jeopardizes its very financial stability. Loans from Palestinian banks to the PA amount to 14% of the total assets of the local banking system, and 112% of its capital.

“In principle, the Palestinian economy suffers from the same problems that characterize the Arab economies in a broader way,” says Zelkovitz. “It relies on support payments — allowances that come from the outside — and suffers from a bloated and unproductive public sector whose sole purpose is to create stability, to enable the government to stay in power.” When the government is the main source of jobs, the result is political dependence on it, he explains.

It also begs the question of where the money goes when Palestinian GDP increases. “Because of the inflated public sector and the dominant elite in the country, growth does not lead to significant social change,” Zelkovitz says.

The West Bank is not rich in natural resources. It never went through an orderly industrial revolution or produced technology. Today’s Palestinian economy has no natural ability to develop into an economy that does not rely on traditional industries, he sums up.

Under the Paris protocol that defined Israeli-Palestinian relations, the Palestinians may not issue their own currency, issue debt or charge value-added tax independently. In many ways the PA is more like a local than a national government, says Prof. Arie Arnon of the AIX Group, a French-Israeli-Palestinian-international economic study team. The PA replaced Israel’s Civil Administration in providing civilian services in the West Bank but when it comes to financing, they’re like a local government.

“They don’t collect taxes on imports, but get them through Israel. They do not control the number of workers in Israel. On the bottom line, they don’t control central dimensions of economic policy. The issue of independence is especially relevant to infrastructure such as electricity and water, where they depend on us. Israel always told them: ‘You should not develop your own infrastructure, it costs a lot of money. Use our electricity and water.’ Politically it was expedient, but it also relates to the question of how much Israel wants them to have economic independence,” Arnon says.

Some argue that the current situation is inevitable. “It isn’t easy for such a small economy to be independent,” says Karni. “That’s why many Palestinian politicians say, after an agreement, we’d be independent for one day, and the next day we would establish a federation with Jordan. Also, the customs union is better for the Palestinians. If they tried to impose high taxes or tariffs on products sold there, very quickly we’d see more smuggling.”

It might not pay for them to issue a currency, says Arnon, to avoid issues of inflation or seeing its currency not honored, “but that’s their problem. The demand for a customs union and uniform VAT at the time stemmed from Israeli fear that Israelis would treat the PA like Eilat [a VAT-free city], going to Bethlehem or the Dead Sea to buy cheap electronics.”

If the desire to protect certain segments of the Israeli economy from cheap products in the territories played a role in economic agreements two decades ago, the economic climate in Israel has changed since. Today, the trend in Israel is to open local markets to competition in order to lower the cost of living. As far as consumers are concerned, exposure to cheap products next door can only help.

Never mind the politicians: Palestinian businessmen want ties with Israel, says Karni. They want to be middlemen between Israel and the Arab world.

However, some caution against the illusion of “economic peace.” Prime Minister Benjamin Netanyahu used this term repeatedly, even as head of the opposition. Even Naftali Bennett and Ayelet Shaked have mentioned it in connection with thoughts of appeasing U.S. President Donald Trump with a gesture.

“These statements are sometimes based on the assumption that economic peace will make the Palestinians strong enough to make political peace," says Benziman. “But the perception that this dimension can be strengthened without tackling the tough issues like borders, refugees and prisoners is hopeless. I think the politicians are also aware of this. For Palestinians, talk about economic peace is a sort of perpetuation of the occupation. In any case, they will want a state with geographic contiguity, and part of Jerusalem.”

“The Americans stress the economic development of the Palestinian Authority, assuming that the motivation for violence will diminish because they will have something to lose. But that isn’t accurate,” Gadi Baltiansky, the director of the Geneva Initiative, says. “The first intifada erupted in 1987 when the Palestinians’ economic situation was better than it had been. They simply decided they didn’t want Israeli rule any more.”